FSA ‘far too lenient’ over split-cap mis-selling

By Ian Fraser

Published: Sunday Herald

Date: May 19th, 2002

Lawyers representing those left penniless after investing in split capital investment trusts argue report has let those responsible off the hook, says Ian Fraser

THE Financial Services Authority has been “far too lenient” with fund management groups and independent financial advisers who egged on investors to put their money into split capital investment trusts, according to lawyers representing people left penniless through their exposure to the beleaguered sector.

The lawyers added that the FSA’s “feedback report”, published last Thursday, offered very little hope for the thousands of investors who have lost money in “split-caps”.

Stephen Alexander, a partner in London-based solicitors Class Law, said that Howard Davies’s FSA had failed to tackle many of the issues associated with the beleaguered sector.

“The FSA has been far too lenient,” said Alexander. “IFAs ought to have been aware that splits were not low-risk investments. It’s true that the adverts were misleading. But just because adverts were misleading, it does not excuse IFAs from not letting their clients know that these were not low-risk investments.”

Class Law is currently putting together a compensation claim valued at between £70 million and £100m levelled against fund management groups and IFAs, on behalf of around 1,700 investors. It will hold a meeting for aggrieved investors on Thursday at the Holiday Inn Crowne Plaza in Edinburgh’s Royal Mile.

“I don’t think [what the FSA is saying about] mis-selling is damning enough,” added Leon Kaye, senior partner in Leon Kaye solicitors, another firm putting together a class action for aggrieved investors. “I think companies will sit back on reading this and think they don’t have much to fear.”

The FSA said last Thursday that, after months of softly softly talks with players in the questionable investment sector, it will now formally investigate a “contagious cocktail” of mismanagement, following a flood of complaints from investors. It said a number of split capital trusts – marketed as a safe way to save for school fees or retirement – had suffered problems after gearing themselves up with bank borrowings and then incestuously investing in each other’s funds.

They often did this through desperation to find shares that would provide sufficient yield to maintain their promised payouts as markets fell – and yet they made scant reference to the high-risk strategy in prospectuses and other literature.

Without naming names, the FSA slammed trusts, managers and advisers for “deluding either their customers or deluding themselves” about the risks of certain types of split-cap shares. It said 11 split-caps had more than 70% of their assets in other splits and that others had significant cross-shareholdings.

This has already created a domino effect in the industry as funds suspend their own dividends, often beccause they have suffered dividend cuts on their own investments.

However, the City watchdog did give the £13 billion splits sector as a whole a clean bill of health.

“While a minority of funds have created a contagious cocktail of cross-investment and high borrowing, the investment trust sector as a whole does not currently pose particular risks or problems,” said John Tiner, the FSA’s managing director. Tiner remains convinced that “splits” are an efficient investment vehicle for investors wishing to gain stock market exposure, so long as they understood the risks.

Splits are specialised funds which have various classes of share, yielding either income or a lump sum at the end of a fixed period. They were supposed to be a flexible product that would suit investors with different appetites for risk. But they were not suitable for bear markets and many have performed abysmally since the stockmarket went pear-shaped in March 2000, a downturn unforeseen by their cheerleaders.

Most trusts have seen their shares plummet in the past few months, in some cases by as much as 98%. Out of 134 splits currently on the market, 11 have suspended their dividend, five have been forced to restructure due to burgeoning bank debt and one has gone bust.

The sector’s precariousness has been fuelled by billions of pounds’ worth of loans from HBOS, The Royal Bank of Scotland and Robert Fleming.

The FSA is to investigate allegations that certain fund managers – known as the “magic circle” – colluded to boost share prices by buying each other’s stock. The web of cross-shareholdings and incestuousness between trust companies and trust directors has raised eyebrows – even in the investment industry. Chris Fishwick, a highly paid director of Aberdeen, sat on around eight split-cap boards.

Aberdeen, BFS and Exeter Investment, the three biggest players in the sector, now find themeslves at the epicentre of the FSA’s investigation. But a number of IFAs and other asset managers will also be drawn in.

The FSA wants to find out if investors were deliberately misled by intermediaries and trusts into believing that shares in splits – which were promoted as offering fixed capital growth – were low risk.

Where there have been breaches of its rules or principles, the FSA says it will take action. This could include unlimited fines for directors and companies concerned and a public rebuke. It may also force firms to compensate the new poor.

The possibility of such payouts has been hanging heavily over Aberdeen and other firms in the sector since the FSA started its initial inquiries in December. Aberdeen’s share price has plummeted by 35% this year alone. But Piers Currie, Aberdeen’s marketing director, said that split cap boards and managers had “taken all necessary steps to restore market confidence in the sector”. Aberdeen has also offered to waive management fees on trusts it manages and has extended a £6m loan to one trust to keep it afloat.

The FSA advised consumers who believe they have been mis-sold trusts to seek compensation directly from firms. The FSA is also considering a “fundamental review” of the listing rules to ensure that trust boards have a majority of independent directors and that the investment behaviour of trusts can become more transparent.

Tiner added: “Seeing these investments promoted as safe as houses – or having more safety features than a Volvo – suggests to me that some funds and advisers have been either deluding their customers or deluding themselves.”

Annabel Brodie-Smith, director at the Association of Investment Trust Companies, said only a minority of splits had experienced problems.

“We would like to see the investigation concluded as quickly as possible, in the best interests of shareholders.”

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